Colin Buchanan and Partners For the European Commission

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2 1. INTRODUCTION Purpose and Organisation of Guide Overview of Contract Design Definitions Information Sources Layout of the Report KEY POLICY ISSUES Introduction Contract Types External Constraints Budgetary constraints Local Policy Planning of Services Pricing Integrated Ticketing Quality of Service Issues CONTRACT DESIGN Introduction Design of Contract: Outline Decision-Making Process Contract Terms And Conditions Contract Size Contract Length Concessionary Fares Asset Ownership Personnel Accounting and Disclosure Issues Audits, Monitoring and Arbitration Variation and Termination Clauses Penalties and Incentives Customer Feedback Compensation Methods Risk Sharing Final Check-Lists Problems with Contracts IMPORTANT CONSIDERATIONS WHEN TENDERING General Pre-Qualification Full Tendering Post Tender Negotiation Other Features Pertinent to the Tendering Process Soft Processes Inclusion of Quality Criteria in the Tendering Procedure Obligations that result from EU requirements Open, closed and negotiated procedures CONTRACT MANAGEMENT Introduction

3 5.2 Informal Monitoring Formal Monitoring CONCLUSIONS Contract Design Contract Management

4 1. GUIDE TO CONTRACTS OVERVIEW 1. Introduction Describes the background to the guide and how it was prepared. 2. Key Policy Issues Describes a series of policy issues on which the authority will need to decide how much control they want to retain. Including: service planning, pricing and quality 3. Contract Design Highlights issues likely to arise in contractual discussions such as contract size/length, penalties/incentives, asset ownership. 4. Important Considerations When Tendering Covers the stages of the tendering process and addresses soft issues and also EU legal requirements 5. Contract Management Provides advice on how to manage contracts, including monitoring issues 6. Conclusions 1-4

5 1. INTRODUCTION 1.1 Purpose and Organisation of Guide The European Commission has introduced a proposal for a Regulation of Public Service Requirements in Public Passenger Transport. This will require that public service contracts are concluded by authorities if they wish to award an exclusive right and/or an operating cost subsidy to an operator. In many cases, the Regulation will also require the opening of public transport markets to "Controlled Competition" This Guide to Contract Design and Management provides a practical information source for authorities and operators who are either facing the need to contract for the first time or who are interested in improving the awarding and management of contracts Specifically, it informs those embarking on such ventures of: (a) (b) the options available; and good practice when: designing contracts; tendering; and managing those contracts once in place In this first chapter: a number of important terms are defined;. 1.2 Overview of Contract Design The process of contract design, which proceeds out of the above, is essentially two-stage (see Figure 1.1): an initial decision on the basic form-of-contract; (covered by Chapter 2) predicated on decisions on the inclusions, and exclusions, and specific form of each contract clause (covered by Chapter 3). There are no prescriptive solutions and much depends on local conditions. 1 See Commission document COM(2002)107 of

6 Present Situation Essential Questions Present Deficiencies? Ranking of Deficiencies? What is Practical? Clause-by-clause analyses External Influences Local Social Policy Goals and Objectives Basic Form of Contract How much flexibility is required? Constraints Legal environment Physical Environment Contractual Relationships with Third Parties How long should Contract run? Alternative Solutions What are the needs for Penalties and incentives? Decision on Specific Contract Clauses What are the intended division of risks and how can these be achieved? Figure

7 1.3 Definitions For the purposes of this Guide the term: (a) "Controlled competition" refers to the awarding of an exclusive right to operate a route, or a network of routes, to an operator (or possibly a consortium) following a competitive process. Along with, or instead of, the exclusive right, the Authority may also grant subsidies to the successful operator in compensation for the fulfilment of public service requirements; (b) "Authority" refers to a public or publicly-owned organisation with a legal responsibility to plan or regulate public transport services in a specified geographic area; (c) "Operator" refers to any organisation with a contract from an "Authority", usually for a fixed period of time, to provide or organise public transport services; (d) "Deregulation" refers to a situation in which operators are largely free to enter and exit the market for transport services at will and to compete with each other on the ground - though in certain circumstances, there may remain fixed periods of notice for start-up and service withdrawal and caps on the maximum fares that might be charged. 1.4 Information Sources This Guide has been produced as part of a study for the European Commission Directorate-General for Energy and Transport which included the collection of 49 contracts between Authorities and operators. Summaries of these contracts will be placed in a database available through the website of the European Commission Directorate- General for Energy and Transport ( 1.5 Layout of the Report The Introduction is followed by: Key Policy Issues (Chapter 2). Contract Design (Chapter 3); 1-7

8 Important Considerations When Tendering (Chapter 4) Contract Management (Chapter 5); and Conclusions (Chapter 6). 1-8

9 2. KEY POLICY ISSUES 2.1 Introduction Contracts are the mechanisms for formalising an agreement between two or more parties for the delivery of either goods or services. In the context of this Guide, their role is to formalise the relationship between an Authority and an operator The intention is most frequently: - to separate day-to-day management and short-term planning from strategic policy, regulatory and longer-term planning functions; and - to identify clearly the costs of operating specific services with appropriate levels of service quality. In particular, the following questions should be addressed before determining the specifics of a contract: (a) what are the perceived deficiencies in the present provision of services - inefficient? insufficient capacity? too much capacity? slow to respond to changes in the market? low quality-of-service? drain on public finances? no incentive to improve? poor marketing? inflexible operations/management? poor integration with other services? top-heavy management? poor labour relations? (b) can the presently perceived deficiencies be ranked according to severity? (c) can a set of realistic goals and objectives be formulated - and/or have these already been formulated in Statements of local policy? (d) can a number of alternative "solutions" be formulated? (e) what local, legal, institutional and other matters constrain the form of solution? Two of the above, (c) and (e), are, fully or partially, external influences and, as such, must have over-riding influence on the form and content of any contract Contracts are important tools regardless of whether the operator is owned privately, or by the Authority or another public body. They are important whether or not they are awarded following a competitive 2-9

10 procedure. They can define a wide variety of objectives - transport, economic, financial, social, environmental not only on behalf of the Authority but also of other local, regional, or national organisations. Consequently, their use is often promoted by external regional, national or supra-national agencies Contracts have been used to change the relationship between Authorities and local publicly-owned service providers, either by these providers being replaced by new operators or to distance Authorities from the local publicly-owned service providers and to make the providers clearly accountable for quality-of-service While some officers within some Authorities have resented the consequent diminution of their powers, most, in the interviews undertaken as part of this Study, have expressed satisfaction that they (the Authority) no longer had to be involved in the day-to-day aspects of public transport operations Contracts must typically concentrate on different issues in different market contexts. For example: - when operations are provided by a publicly-owned organisation which may subsequently be privatised, they must separate policy/regulatory issues from the operation of the service; - in a fully deregulated market, they might procure services the private sector is otherwise unwilling to provide; - in a competitive market where the Authority wishes to retain control over network planning, they might define integrated ticketing and fares policies and (at the same time) encourage competition between operators; - in a partially competitive market where the Authority wants to provide the largest network of services by cross-subsidising loss making routes with profitable ones, they might allocate monopoly operating rights (on a competitive basis) for specific services. 2.2 Contract Types The basic types of contract are: (a) Management Contract: The Authority retains ownership and control of all depots and vehicles, retains all revenues and pays for all 2-10

11 capital and recurrent expenditures. The Authority may also be the employer of most or all of the staff engaged in providing the services. Operator involvement is confined to the professional management of operations on behalf of the Authority - these services being, normally, for a fixed, negotiated period of time and for an agreed price 2. (b) Gross Cost Contract: The Authority relinquishes control of the vehicles/rolling stock and possibly also of the depots/other infrastructure (though may retain ownership or transfer ownership to a separate body) and requires the operator to operate, and perhaps also provide, to certain specified quality-of-service standards and for an agreed price, the required fleet of vehicles. Under gross cost contracts, all revenues (from fares and other sources) are transferred to the Authority and the risks absorbed by the operator are confined to those associated with the cost of operations. (c) Net Cost Contract: The Authority relinquishes control of the vehicles/rolling stock and possibly also of the depots/other infrastructure (though may retain ownership or transfer ownership to a separate body) and requires the operator to operate, and perhaps also provide, to certain specified quality-of-service standards and for an agreed subsidy or premium, the required fleet of vehicles/rolling stock. The operator is normally entitled to all revenue (from fares and other sources) and could bear a number of additional risks. These typically concern disturbances to traffic, fluctuations in revenue, and changes to the regulatory regimes. Negotiated risk-sharing clauses in the contract may, however, limit the exposure of the operator to these risks. (d) Net Cost Contract with Investment (NCCI): In this contract type, the Authority contracts with an outside organisation to provide (or, in the case of existing systems to maintain or upgrade) the majority of the fixed and moveable assets and, simultaneously, to provide services to specified quality-of-service standards. The operator must, consequently, provide from internal resources or via external financing the required inventory of fixed and moveable assets. The operator will also retain all revenues and will absorb either all, or a contractually agreed portion of, traffic/revenue risks as well as the risks associated with construction. Risk-sharing may also extend into the areas of regulatory risk A NCCI is often the most appropriate type of contract for situations where previously there were no services and where there is also a requirement to provide depots and/or other infrastructure. New light rail schemes are often covered by long term contracts of this nature; 2 Such contracts may not be fully compatible with proposed EU legislation, see COM(2002)107 in particular article 6(b) 2-11

12 the Croydon light rail system, for example (see contract U15 3 ): whilst the operating contract is for 5 years, the entire contract, including the build period, is for 99 years. A period of years is, however, more common These contract types are differentiated largely by the extent to which they transfer risk from the Authority to the operator. This is summarised below 4 : Contract Bearer of Risk: Type Cost Risk Revenue Risk Investment Risk Management Authority Authority Authority Gross Cost Operator Authority Authority or Operator Net Cost Operator Operator Authority or Operator NCCI Operator Operator Operator The choice of contract type will depend upon a number of factors: External constraints Budgetary constraints Local policy Planning of services Pricing Integrated fares Quality of service issues These will be looked at in turn. A summary of the considerations that might lead to decision on the most appropriate form of contract is provided as Figure External Constraints When deciding on the type of contract, the Authority should first take into account any over-riding legal and physical restrictions on the operating environment. In the UK, for example, the Strategic Railway Authority is reducing the number of operators at London termini to 3 The reference here (and throughout this Guide) refers to contract summary numbers used in the contracts database mentioned in paragraph It is also possible to have contracts where risk e.g. revenue risk is shared; but the four types presented here were the ones most commonly found during this study. 2-12

13 ensure that the impact of physical constraints of the railway network is reduced The most commonly-observed constraints, and some commonlyfound goals and objectives, are separately considered in the paragraphs which follow. The lists are not definitive - nor can they be. (a) The legal/regulatory environment The legal environment within the EU varies from full deregulation to situations in which the Authorities have full control over public transport issues. The choice of contract type could therefore be limited by the legal environment in which a particular Authority operates. Case (U10/U11) In Strathclyde, deregulation (required by law) permits operators to introduce and withdraw services almost at will. This precludes the implementation of an integrated fares structure and prohibits direct competition from subsidised or otherwise-supported services. In areas or at times when no operator is prepared to provide services, small-scale "net or gross cost" contracts can be employed, but these services cannot be protected from an incoming competitor and so the operator s incentive to attract more passengers may be limited. Contracts covering area-wide networks are impossible to implement. (b) The Business Environment Three factors are important: (i) The structure of the existing industry and, in particular, the numbers of small and large operators: If there is a large number of existing small operators (more likely in the case of bus than rail services), Gross Cost contracts may be preferred. Net Cost contracts, which have higher risks (particularly uncertain passenger revenue and in some situations a changing competitive environment) are not generally favoured by small operators. The larger the size of the network for which contracts are sought, the lower will be the number of potential operators; although, conversely, large operators will be less interested in applying for small contracts. (ii) Contractual relationships with third parties: These relationships may preclude certain types of contract, or at least dictate the need for special clauses. For example, the contracts between the UK Strategic 2-13

14 Rail Authority and the Train Operating Companies (TOCs), besides being constrained by the imposed legal/regulatory environment, are also constrained by the contractual relationship that the infrastructure manager (formerly Railtrack) has with the Authority (contracts U20- U22). It has been noted that during recent retendering, the desires of the TOCs to provide improved services (for which they could reasonably charge higher fares) required infrastructure improvements that encroached on the responsibilities of Railtrack. As the number of parties involved increases, the number of contracts involved increases exponentially. It is important to ensure that the dividing lines between each party s area of responsibility do not become blurred. (iii) Monitoring Difficulties/ Corruption Problems: An authority working in an environment where monitoring difficulties, or even corruption, have been experienced, or are deemed to be a significant risk, might choose to avoid Gross Cost contracts. These require the operator to pass on to the Authority all revenue collected and to be diligent in the collection of such revenue. 2.4 Budgetary constraints Transport authorities, at local, regional or national levels of Government have, of course, to work within budgetary limits The extent of subsidy that Authorities are able and prepared to pay - overall; to individual routes or services with high perceived social value; and/or of cross-subsidy between routes or services in specific areas - is an important input. The level of funding available will influence decisions not only on the type of contract but also on contract size and on policies towards fares (including concessionary fares) and integrated ticketing (see sections 2.7 and 3.6) Where an authority cannot absorb the risk associated with possible variations in public transport revenues, it may want to use Net rather than Gross Cost contracts so that the revenue risk is passed to the operator If a contract is being tendered, then the Authority has to be reasonably confident that the cost of the bids to provide the specified services will not out-strip the budget for subsidy available to the Authority. This should not be a problem if the Authority has good cost information from the incumbent operator (see section 5.3) or is basing the service specification on the existing level of provision. However, for new routes (with or without new infrastructure) the likely cost to the Authority may be less predictable. 2-14

15 2.4.5 One (partial) solution would be to stagger the award of contracts so that the Authority can build up an increasingly accurate picture of the likely cost associated with subsidising services. An alternative approach would be for the Authority to tender on the basis of "quality of service" (against a fixed level of subsidy), selecting the bidder offering the best level of service - this defined in terms not only of the number of bus/train-kms but also in the numbers of off-peak service and/or services to areas where services might normally only be justified on social grounds In many cases, additional investment subsidies from third parties are also available for the operators. In such cases it is in the interests of the Authority to ensure that the operator solicits these financial resources as it could enable a reduction in the level of subsidy. 2.5 Local Policy Another factor influencing the choice of contract type will be local policy The public transport goals and objectives of the Authority will generally derive from the wider policies of Local and/or Central Government. These policies may be at significant variance with operators objectives and mitigate against certain types of contract. For example: Integrated Fares: The Authority may wish to introduce or maintain a system of integrated fares and ticketing (see sections 2.6 and 2.7). If the authority also decided to award a series of small Net Cost contracts, then complex and consistent revenue sharing formulae would have to be devised, administered and monitored. The cost of monitoring would also need to be covered. Integrated fares systems are, consequently, more difficult to implement with Net Cost than with Gross Cost contracts; cases do exist, nonetheless of Net Cost Contracts coexisting with integrated fare structures (as happens with London Buses contracts) Local policy considerations may make it desirable for the contract to have a degree of built-in flexibility. There are two levels of flexibility that should be considered: flexibility within the terms of each specific contract and flexibility within the total system of operation. This question is addressed in the section on Variation and Termination Clauses in section

16 2.6 Planning of Services It is incumbent on Authorities to define, in broad terms, the sort of public transport services required. Detailed service planning (concerning the details of routes, frequencies, timetabling and hours of operation) can be undertaken by the Authority or by the operator, or by some combination of the two. Each party s role in service planning should be set out in the contract In some instances this function is carried out almost entirely by the Authority and the operator is required to provide tightly-defined services. For example, in Copenhagen and London, there is no flexibility allowed to the operator in any of these matters - even the number of vehicles required to operate each particular route is defined (contracts U04, U05) The opposite extreme is to give the planning function entirely to the operator. This is found, for example, in a fully deregulated system such as bus services in the UK outside London and Northern Ireland. In this case, the Authority can still use contracts, but only to top-up (with non-commercial services that are needed for social reasons) those services that operators decide to run for commercial reasons In between these two extremes lie a range of options whereby responsibility for planning is shared between the Authority and operator. One option is for the Authority to specify minimum required levels of service but for operators to be free to add additional routes or frequencies. That is the approach now adopted in Britain for rail contracts. Similarly, in New South Wales (Australia), minimum rather than absolute service levels are specified in the contract (see Contract Summary N02) Another flexible approach is to allow for changes to the network when both the operator and the Authority agree. In these situations, such as in Hong Kong (N01), both sides may propose changes Decisions regarding control of the planning function have major implications for the choice of contract-type. If operators are expected to bear some of the revenue risk (under a Net Cost or NCCI contract), they may reasonably expect to have appropriate input to the planning function. 2-16

17 2.7 Pricing Public transport plays a key social role. For the poorer sections of society, it is often the only means of access to the places where employment and services are located. Public transport is, moreover, increasingly being promoted for environmental reasons. Pricing is, consequently, politically sensitive and control often retained either by the Authority or some other organisation (such as the political body to which the Transport Authority reports) other than the operator Under this approach, the Authority presents potential operators with the tariff system as a given in the contract. A contract can then be awarded on the basis of the minimum subsidy the operator is prepared to accept (or the maximum premium the operator is prepared to pay) in order to operate either a single route, a bundle (several lines, not connected) or a network of services Authorities clearly have a duty to protect public transport users from the natural inclination of all monopoly providers to exploit their position through higher prices. If, however, competitive pressures can be introduced, these can also be an effective mechanism for reducing prices. The prices offered by low cost airlines have, for example, forced established operators to reduce their own prices and costs. If there is genuine competition, then the market itself can generate cheaper prices. Such a competitive environment must, however, be sustainable, with freedom of entry to newcomers and no advantages retained by established operators A middle option between full control of fares and deregulation might be for the Authority to set maximum prices for basic services and to allow operators either to introduce: cheaper fares or special offers whenever these might be commercially viable; and/or higher fares for premium services: such a system is in place in Britain in the rail sector and has resulted in a proliferation of special fares targeted at specific markets. By using these promotions to grow the off-peak and premium markets, the operators have managed to increase both patronage and revenues. 2-17

18 Case (E01) Fares for each public service obligation air route in Ireland are divided into three tranches: Tranche 1 has a maximum fare (MF1) which must account for no more than 40% of capacity offered; Tranche 2 has a lower maximum fare (MF2) which must account for at least 40% of capacity offered; and Tranche 3 (which covers the remaining 20% to 60% of capacity) has no fare restrictions (call the fare set in this tranche F3). Thus, to give two examples of possible revenue streams, the operator may receive (assuming 90% load factor in each case): 35% * MF1 + 45% * MF2 + 10% * F3 39% * MF1 + 50% * MF2 + 1% * F3 Both of these revenue streams satisfy the constraints on revenue set out above There may be a link between the degree of freedom given to operators to set prices and the likelihood of these operators to accept revenue risk under a Net Cost or NCCI contract. Due to the difficulties involved in quantifying levels of tariff freedom and in procuring the discount rates used by operators to evaluate the value of contracts (due to commercial confidentiality), this hypothesis is, however, difficult to prove. 2.8 Integrated Ticketing Many major cities have or will have more than one public transport mode or operator and integrated ticketing is a vital element in maximising the efficiency and attractiveness of the network as a whole. In such cases price competition between operators could be detrimental and so the Authority may want to retain control In circumstances where there is more than one operator within an integrated ticketing system, and the operators bear the revenue risk (Net Cost or NCCI contracts), there will normally have to be arrangements for the reimbursement of revenue from ticket sales between the operators. The formulae and auditing procedures for such sharing can take many forms - but might, typically, be proportionate (or a proportion weighted against the perceived differences in passenger-km operating costs by 2-18

19 each mode) to the audited estimates of passenger-km performed by each operator The auditing procedures are, consequently, very important. They can be based either on: ticket sales; or on-board, continuous, surveys Whichever auditing method is chosen, the procedures that will be used should be defined and incorporated into the contract so that the computational outcomes of the procedures have the required legal force. Contracts which do not specify such an approach have, in the past, given rise to disputes. The specific data collection methodologies have been deemed by one or other party to under, or over, record actual movements. Case (U15) The on-board surveys on the Croydon trams (passengers were interviewed as to the type of ticket they were using and their final destination) were believed by the contracting Authority to over-record use by integrated ticket holders. These persons tend to make longer trips and, therefore, stand a greater chance of capture during the surveys (the discrepancy was discovered when average trip lengths were computed using data derived from these and other survey sources). The Authority, consequently, revised its data collection methods and is now attempting to claw-back what it regards as earlier overpayments to the operator The cost of such surveys where there are a large number of operators is one reason why net cost contracts are not popular amongst some Authorities. For example, for a one-off survey, which attempted to interview every passenger on each train operated by two companies concerned (in the UK, there are several rail routes served by more than one operator) on one weekday, one Saturday and one Sunday (spread over several weeks) the cost of this was about 50,000 (approximately 80,000), which represented about 0.17% of the annual revenue at stake. The Croydon survey mentioned above costs about 250,000 (approximately 405,000) per year, which is about 3% of the annual revenue at risk. 2-19

20 2.9 Quality of Service Issues The quality of public transport services has important implications both for customer satisfaction and for the social, economic and development prospects of the areas served. There are a range of quality issues from the type of vehicle to the friendliness of the staff. A key issue in contracts is how to maintain or improve quality of service. This is particularly (although not exclusively) the case in Gross Cost contracts where the operator would benefit from operating cost savings but has no direct incentive to increase demand (in fact lower demand generally reduces operating costs) Most quality issues are capable of specification and measurement but often this requires a degree of effort that may not be compatible with the importance of the issue. A few key issues are set out below: (a) Vehicle specification - Specifications may include standards for all or some combination of: type of fuel used, carrying capacity, ratio of seats to standing passengers, quality of seats, seat pitch, head rests, seat width, width of corridor, climate control, ceiling heights, accessibility for the disabled, maximum age of vehicle (or maximum average age for fleet), the use of single or double-decked vehicles, radio equipment (for operational management), numbers and position of entries and exits, onboard passenger information etc, whether one or two-person crews, acceptable livery, availability of toilets, cleanliness, procedures for dealing with graffiti etc. If the authority sets detailed technical requirements it is important that they are realistic and consistent. The operator will be reluctant to take any responsibility for technical problems resulting from inappropriate technical specifications. Very specific specifications will be likely to increase an operator s costs (and therefore, in some cases, the level of subsidy paid by the authority). On the other hand, loose specifications may preclude obtaining the desired quality-of service and could therefore lead to declines in passenger numbers. (b) Service Reliability Targets quality of service as perceived by passengers is often closely aligned to reliability. Many contracts include targets for service reliability and penalties/bonuses for achieving them (or not). Clear definitions of criteria and targets document the authority's claim of service quality and are the basis for any intervention. Quantitative and qualitative definitions can be used (e.g. "not more than 5% of the trains should be delayed for more than 5 minutes"). (c) Customer Satisfaction this can be measured, and changes over time monitored, through the use of "Customer Satisfaction Surveys" which interview actual customers or "Mystery Traveller Surveys" where 2-20

21 trained staff rate quality aspects of journeys The following two case studies illustrate the application of service quality issues. Case (D03) The contract between Free State of Thuringia and the rail operator Südthüringenbahn GmbH specifies many quality of service indicators, including: Quality of personnel Customer service Cleanliness of railcars Passenger safety Connections and punctuality Cancellation of trains Distribution Passenger information Management of trouble shooting There seems to be a strong trend towards increasing the role of quality measures in determining the rewards paid to operators. Some operators, however, argue that the key indicator of quality is the number of passengers and that this is far easier to measure than the above factors. 2-21

22 Case (U04/U05) In London, penalties are imposed for lost mileage that is considered to be under the control of the operator. These are where the cause is staff shortage, bus not fit for service or bus fails in service. Operators performance is measured against Quality of Service Indicators (QSIs). These differ for high frequency buses and low frequency buses. For high frequency buses the main indicators are the times at which buses are expected to pass an observation point; these are then compared with actual buses and average scheduled wait is compared against average actual wait. This information provides average excess waiting time, ratio of actual wait to scheduled wait and the probability of waiting 10, 20, or 30 minutes for a bus. For low frequency buses the assessment of punctuality is based upon a comparison of observed departure and scheduled departure. Buses running between 2.5 minutes early and 5 minutes late are defined as being on-time. Buses running between 2.5 and 8 minutes ahead of schedule are early ; those running between 5 and 15 minutes behind schedule are late. Any services where actual times exceed 8 minutes early or 15 minutes late are regarded as non-arrivals/not linked. Contract extensions beyond the five year term will be based upon achievement of QSI thresholds approximately 10-15% above the minimum performance standards. Minimum performance standards and QSI thresholds vary according to length of route, fare zones, major centres, corridors and stand constraints. The standards will be set out in the tender document and will normally be fixed for the duration of the contract. 2-22

23 Pre-contracting Reduces ability Affect on environment to: contract type: Advanced Deregulation...provide areawide networks Legal Constraints.provide integrated fares/ systems provide subsidised services in instances where private sector is not otherwise interested Only small-scale net or gross cost contracts are sensible and these only on routes or at times with no other public service operations Third party relationships...tender, particularly if based on quality-of-service improvements Adds difficulties to all contract types Larger urban centres.let small net cost contracts - as increases both present and likely future risks to franchisees Small net cost contracts do not work easily Physical Constraints Only few depots available.let to a large number of franchisees Large net or gross cost contracts are favoured Only few companies in market.let to a large number of franchisees Large net or gross cost contracts are favoured Deregulation as policy? Management contracts are inappropriate Social and Political Goals and Objectives Integrated fares are policy? Monitoring difficulties/ corruption?.let net cost contracts.let gross cost contracts Favours gross cost contracts Favours net cost contracts Dynamic external environment/contract of long duration have a rigid contract (contract must instead be flexible) Should incorporate outwith specific contracts but within the total system of operation Figure 2.1 Should incorporate flexibility within the terms of each specific contract 2-23

24 3. CONTRACT DESIGN 3.1 Introduction This chapter goes into detail of specific aspects of a contract. The chapter aims to highlight the issues which are likely to arise in contractual discussions between operators and Authorities. The chapter then closes with an examination of problems that arise with the development and implementation of contracts. 3.2 Design of Contract: Outline Decision-Making Process The design-of-contract decision-making process which follows can be defined by a list of questions. This list concerns the likely outcome of alternative solutions and of a number of other related features that bear on the nature of the contract, viz: what practical results might each of the formulated "solutions" achieve? Many "solutions" will require some form of goals/objectives compromise: in this regard it may be useful to construct a matrix showing the extent to which each option might lead to the achievement of each goal/objective. how much flexibility is required? Most markets will, over time, change and most contracts ought, consequently, to be sufficiently flexible to change in line. It is therefore important to make some assessment of the types of on-the-ground changes most likely to occur and of the nature of the desired flexibility. The longer the time period that the contract is to cover, the greater the level of flexibility that may be required in the contract. how long should the contract last? Trading off the flexibility associated with short-term contracts against the greater incentive to make capital investments that a long-term contract might engender is important (in this regard, much may depend on the perceived quality of likely tenderers and the perceived quality of existing vehicles and infrastructure). what are the needs for penalties and incentives? These will depend/impinge on political and other considerations, particularly monitoring and auditing procedures. what is the intended division of risks and how can this divisions be achieved? In most instances the division of risks will be specific to the contracting circumstances; it is, however, important that all 3-24

25 parties understand their contractual positions. However, it should be noted that as the level of risk that the Authority wishes to transfer to the operator rises, the number of bids received may diminish and the "prices" that tenderers will bid are likely to be higher. 3.3 Contract Terms And Conditions In addition to the policy issues described in Chapter 2 there are a range of practical issues that need to be addressed in designing contracts. These are: contract size contract length concessionary fares asset ownership personnel accounting and disclosure issues audits, monitoring and arbitration variation and termination clauses penalties and incentives customer feedback compensation methods risk sharing These are described below. 3.4 Contract Size The size of contract has a number of implications, principally in the area of competition. Authorities must balance the competitive advantages (a wide choice of operators and the opportunity to compare their performance) that a number of small contracts can bring against single, or multiple, large-area contracts that are easier to administer and could benefit from economies of scale on the part of the operator Even where operators are not directly competing on the same routes for passengers and revenues, the public will quickly become aware of the different qualities-of-service provided by different operators in different areas: and the more operators there are, the more comparisons can be made. The authority can promote this awareness by publishing comparable performance information; a good example is the quarterly reports published by the UK Strategic Rail Authority on the UK rail operators. The reputation that each company develops can be a strong influence when the time comes for retendering (reputation as such is unlikely to be used as a criterion: it would be quantified via a 3-25

26 requirement to present an experience statement of other contracts and how well these are performing/have performed) It is easier to dispense with the services of an operator underperforming on a small contract (which only accounts for a small proportion of the market) and to find an adequate replacement than it is to dispose of and replace the services of a larger, poorly-performing, operator with a substantial share of the market (a problem that occurred in Hong Kong when China Motorbus was deemed to be poorly performing) Having said this, the difficulties noted earlier regarding the use of small Net Cost contracts in large urban situations and of contracting to a large number of organisations when there are limited available depot facilities are important other factors in deciding on the size of contracts On the other hand, a larger operator is likely to have resources available to take over planning and other functions (such as marketing campaigns) that might otherwise be undertaken by the authority. 3.5 Contract Length Contract lengths may vary according to a number of needs. If the operator is expected to invest heavily in rolling stock or other equipment/depots, then a long period - say, ten years or more - might be appropriate. For bus contracts, or cases where the operator leases the rolling stock, then the length of contracts may be shorter (railway operators in the UK lease almost all vehicles from three large rolling stock leasing companies) Clearly, contracts with short periods will add flexibility to an Authority's management strategy and will allow the Authority to dispense more quickly with services of under-performing operators (although termination clauses can also achieve this). On the other hand, short contracts: - do not encourage operators to make long-term capital investments; and - may encourage operators to concentrate on short-term planning objectives, at the expense of the wider, long-term improvement of service provision (measures that would have long-term benefits but could cause disruption in the short-term include the introduction of new routes, new ticketing systems, long-term information and marketing initiatives and vehicle replacement planning). 3-26

27 3.5.3 Management contracts can also be for long or short periods. Longer contracts provide management with the time needed to learn from experience about local conditions, but make it more difficult for an Authority to dispense with the services of under-performing operators Given that there are advantages to be had with both long and short term contracts, there is some merit in considering either: - contracts which allow extensions for good performance (these are common features of many contracts: for example, London Buses now offer a two-year contract extension in cases where operators exceed certain quality standards); or - contracts that have a rolling termination period of, say, one year from any "notice-to-terminate" being given to this effect (for example, as AB Storstockholms Lokaltrafik has with Swebus Sverige AB) Concessionary Fares Many Authorities use concessionary fares to support social and other objectives for particular groups including children, the aged, the unemployed, police, military etc Decisions need to be made on: - the categories of persons who will qualify for concessionary fares; - the evidence that each will have to provide in order to obtain the concessionary rate; - the methods for determining compensation for operators carrying people entitled to concessionary fares. 6 This determination may be fixed at the time of contract or based on a formula 5 Either approach could be subject to a maximum total contract duration period such a limit is included in the European Commission s proposed PSR Regulation. However, both approaches could be adopted to comply with the total limits proposed (8 years for bus services, 15 years for rail therefore, for example, a or 6+2 or 4+4 year bus contract would be permitted but not a 5+5 or 6+2+2). 6 Authorities decisions in this area will need to take account of EU rules: currently laid down in Regulation 1191/69/EEC as amended by Regulation 1893/91/EEC 3-27

28 incorporating travel data from, for example, periodic on-board surveys Another important aspect to be covered by the contract is the treatment of additional subsidies from third parties. For example, the German Länder are obliged by law 7 to subsidise operators for selling tickets for children and the mobility impaired at a reduced price. Case (D09) In Bad Segeburg, Germany, the operator must establish a subscription system which allows the passengers to buy reduced monthly tickets without having to go in person to a sales point. Opening hours and other availability standards are defined in the contract. 3.7 Asset Ownership A wide range of assets are involved in the provision of public transport: vehicles, stations, depots, tracks and equipment. Contracts should clearly define which (if any) of these assets should be controlled by the Authority Maintaining access to assets is important in fostering competition. Throughout Europe bus tendering has been problematic for new entrants where they do not have access to depot facilities. A shortage of depots may lead to the need for a limited number of operators. A large city with few depots would be unsuited to multiple small contracts and would probably favour large contracts. While some areas in Great Britain, particularly London, have suffered from the sell off of bus stations for other uses, Lombardy have retained their control of theirs. In the UK, railway rolling stock was transferred from the publicly-owned operator, British Railways, to separate rolling stock companies when British Railways was broken up and privatised Decisions on asset ownership are, however, closely linked to the length of the contract (see section 3.5 above) and degree of competition that the Authority desires. Investment in infrastructure with a long life such as depots, stations and railway rolling stock should not be required by a short term contract although it may be appropriate within a longer 7 Personenbeförderungsgesetz (PBefG) 45a for selling tickets to pupils Schwerbehindertengesetz (BSchbG) 65 for allowing free riding to mobility impaired 3-28

29 term contract. Control by operators of stations and/or depots can make competition from other operators very difficult, so these may be best held by the Authority, or a separate independent organisation, which could then and allocate space to more than one operator in the same depot. For example, when coach services in Great Britain were deregulated, the main coach station in London was transferred to London Transport to ensure all coach operators had equal access to the facilities If responsibilities for infrastructure are allocated to the operator this can motivate them to find innovative technical and organisational solutions that will improve cost-effectiveness (and reduce their operating costs). A good example is the maintenance strategy of the "Nord-Ostsee- Bahn" in Kiel. Rolling-stock maintenance is subcontracted to a service company which built a quasi "mobile" workshop that can be removed after the contract ends. This very cost effective solution is unlikely to have been found without integrating rolling-stock maintenance into the tender specification Authorities should consider intervention in asset ownership only if it is a true competition factor. Typically, bus depots in urban areas represent such assets Where ownership is retained by the Authority there is a key issue concerning maintenance to what extent is the user of the asset (the operator) responsible for its maintenance and how is that maintenance monitored to ensure that assets are handed back in an appropriate condition? In Thüringen, for example (see contract D03), the operator is responsible for maintaining the railway vehicles. Failure to maintain these vehicles correctly will lead to unit failures and hence cancellations, for which penalties are incurred. 3.8 Personnel Staff are a key asset in the provision of public transport. Perhaps the largest gain from the use of contracts and competitive pressure derives from improved labour efficiency - greater productivity and more flexibility. Many competitively-awarded contracts involve staff transfers from an incumbent to a new operator (and sometimes from the public to the private sector). This process can be repeated when the contract is retendered It is necessary to take account of EU law in this area. Authorities should therefore refer in particular to national legislation based on Directive 01/23 and the legislation it updates (Directive 77/187) on rules that protect employee rights in the case of such transfers. Where the 3-29

30 Directive applies, it gives existing staff the right to a job with the new operator Contracts (and tender specifications if the contract is to be awarded competitively) should clarify the position of the employees should the operator be replaced by another operator when the contract is renewed. Operators often wish to retain trained staff even when they lose a contract so that they can deploy them to other services Bus crews can be trained relatively quickly so a new operator can, if necessary, recruit and train staff if it wins a new contract and there is no (or an insufficient) transfer of the existing staff. It should be noted, however, that pay levels within the bus industry, unsocial hours and high employment levels in the economy as a whole can sometimes cause problems in recruiting staff By contrast, in the case of for example a large rail contract (for example), it could be very difficult for a new operator to bring in a completely new team in the short term. Some railway staff, especially train drivers, take far longer to train than bus drivers (12-24 months is not unusual). It may therefore be critical that the existing staff transfer to the new operator; otherwise there may need to be long gap between contract award and commencement of services to allow the new operator to recruit and train staff There is also an option of keeping staff within the employment of the Authority, but under the day to day control of the operator. This has happened, for example, in Denmark where rail staff are civil servants. However, as such staff have the right to transfer to other duties elsewhere in the public sector, the incoming operator takes on a considerable risk that key staff will not stay when it takes over the contract. In Denmark, the new rail operator had to offer bonuses to ensure staff stayed on The Authority may wish to specify clearly in the contract a number of other staff-related requirements, viz: qualifications; experience; uniforms; numbers; and the means to ensure that no persons go to work under the influence of drugs or alcohol They may also wish to lay down training requirements. Training will be particularly important if there are perceived deficiencies in the previous operator/employees attitudes to customers or if improved safety standards are to be incorporated into the agreement. Training requirements can include matters such as: the most appropriate manner to deal with passenger queries/difficult passengers; emergency procedures; 3-30